2023-08-08 06:59:17 ET
Summary
- TransMedics Group, Inc. posted exceptional Q2 results with a 156% YoY increase in revenues, reaching the highest second-quarter turnover in the company's history.
- The company aims to have 100% availability over the U.S. continent by mid-next year, with plans to acquire 10-15 aircrafts for its air logistics operations.
- Net-net, reiterate buy, revising the price objective to $150/share.
Investment briefing
Organ logistics company TransMedics Group, Inc. (TMDX) posted Q2 numbers last week with exceptional results on my examination. Revenues were up 156% YoY culminating the highest second-quarter turnover in the company's history.
TMDX has in fact been one of my best-performing positions in the last 18 months, running up the page from ~$22 to $80 at the time of writing, some 263% appreciation of capital. Since I first covered it here on SA back in August last year, the position has run 103% into the money.
There are three major growth points in need of discussion to guide the investment debate for TMDX's equity stock. I'll cover each of these here, with additional focus on projections into FY'23 yearend and beyond. Critically, the company wants to have 100% availability over the U.S. continent by midway next year, and has taken the necessary steps to get there in my view. With 10-15 aircrafts budgeted on its CapEx schedule going forward, it has addressed concerns I had raised last time around the core of its business model-air logistics.
Net-net, based on the updates provided here today, I reiterate TMDX as a buy, revising the price objective to $150/share in doing so.
Figure 1. TMDX price evolution, breaking upper and lower trend lines in last 3-weeks [note: weekly bars].
Figure 2. TMDX extensive run from FY'22 beginning, showing monthly returns
Critical investment facts for discussion
One is certainly cognizant of the recent selloff in TMDX equity after its quarterly numbers posted last week. In my informed opinion, this presents investors with a tremendously attractive opportunity to reduce the average purchase price ("APP") of holding TMDX long. The case it outlined below.
(1). Q2 earnings run-down
Starting with the quarter, numbers were strong at the top-line. Revenues were up 156% YoY as mentioned earlier, pulling to $52.5mm. Of this, domestic sales grew 170% to $49mm, clear illustration the company's U.S. market is adopting its core offerings.
Figure 3. Just check out the revenue ramp from FY'21. By all measures, I believe TMDX can continue and even increase on this going forward.
As a reminder, TMDX books revenues from sales on its organ care system ("OCS"). Primarily, this consists of single-use disposable sets used on OCS consoles . Each new transplant and procedure commands the sale of a new OCS disposable set, meaning customers purchase or rent an OCS console, and a tail of income is built from the addition of new procedures under the same console.
Just for reference, the OCS mimics the relevant organ's internal conditions found inside the body. This is truly a disruptor in the space-there are multiple value-added features of TMDX's offering, including precise tracking and the optimization component.
The divisional breakdown on the Q2 top-line, including the revenue change drivers, are as follows:
- Lung revenues were up 650bps YoY and brought in an additional $0.382mm over the 12 months to Q2 FY'23. All up it booked $2.8mm for the quarter.
- The two major growth drivers were from its heart and liver transportation sales. The former brought in another $8.5mm in sales to $13.5mm, growing 130% to achieve this. A more than doubling in sales is clear indication of TMDX stealing market share in my opinion, given it is miles ahead of the 8.7% compounding growth forecast for the market.
- Meanwhile, the liver transportation segment-TMDX's major breadwinner-was up a tremendous 240% on Q2 FY'22 numbers. This is another testament to TMDX penetrating the market at striking pace.
Given the triple-digit upsides in its heart and liver logistics businesses, TMDX qualifies as a legitimate growth company in my opinion. It pulled this to 70% gross , with product gross of 80%, and a services margin of 28%. To accumulate value, it should be focusing on product sales going forward, naturally.
Figure 3a.
Management upped FY'23 projections and call for $190mm at the top line by yearend, meaning it is ~50% of the way there at H2 FY'22. This would be ~103% YoY growth from last year.
We can therefore expect another c.96mm in turnover should it hit its numbers until then. Compared to this time last year, the firm had only amassed ~39% of its FY'22 annual turnover. Whilst management are correctly cautious in their projections, this serves as good information about the potential momentum it can still gain into the second half. Say it does push past $190mm in sales this year-to $200mm for example-you're looking at ~114% YoY growth.
(2). Growth investments & returns on capital deployed
I'll separate this into two sections, starting with the company's profitability.
Gross capital returns
You'll note in Figure 4 the company's gross capital productivity, represented as the TTM gross profit scaled by total assets, less cash, each quarter. Cash is excluded, even though it has optionality, given the company's recent financing efforts where it raised $400mm in via an offering of 1.5% convertible notes.
Just quickly-some might scoff at the use of convertibles. I can hear the classic criticisms: "Investors will be diluted on the conversion"; "Why not just issue the notes without the conversion feature", and so forth. But consider this. Convertibles are great for the company as it gives a cheap form of financing (150bps in this case-try get that at commercial rates at the moment), and, if the issue is converted, the debt is wiped from the balance sheet. Investors like them, too, as it gives a cheap form of equity with downside cover if the stock doesn't rally. Further, the per-share metrics don't actually change that much on conversion, which, by the way, is activated at $94/share.
More importantly, the company's operating metrics continue to stand out.
Moving away from the accounting realities for a second and focusing on the economic characteristics of the business, you can see the incredible gain in gross productivity below. From Q4 FY'20 to date, TMDX has scaled its performance here by a cumulative 640%.
That translates to the following:
- In Q2 FY'21, it recycled back $0.18 for every $1 invested in its asset base (less cash, as mentioned).
- Skip to Q2 FY'23, the latest figures, and TMDX circled back $0.96-almost 100% gross return on capital.
You simply don't find these kind of numbers scattered everywhere. Only a select few companies, with excellent management teams, and whose economic advantages are hard to replicate can pull it off.
Figure 4.
What does this mean going forward? I've projected TMDX's FY'23 gross margin on its revenues in the 69-70% range. Taking the lower of this, I get to $131.86mm in gross for the year on $147mm in operating assets (no cash or equivalents included in these assumptions either). I get to $202mm in operating assets by H2 next year on this growth. For more detail on the calculus of asset growth, see the section below on CapEx etc.
This gets me to $0.90 in gross productivity for the year. I do have a scenario whereby TMDX prints $166.7mm in gross for FY'23, which gets me to $1.13 in gross for every $1 in assets-tremendous operating leverage in my view. Even an average of this range spits out $1.01 per $1 in assets, a 101% gross capital return. Needless to say, these are bullish findings.
Capital investments for growth
TMDX badly needed to address its operating expenditures tied to logistics. Quite a paradox because ideally, it would do this anyway-but the issue was it was making its deliverables via charter flight[s] at the time of my last publication. This was not sustainable. In effect, TMDX needs to create a national logistics network, including an aviation network, in order to meet its objectives-providing enhanced logistics for time and temperature-sensitive biologic commodities.
Well, consider that the company signed a definitive agreement in Q2 to acquire Summer Aviation, a charter flight operator in the U.S. Financial details of the deal were not disclosed at the time. The transaction is expected to close in Q3 this year, and will see all Summer's team folded into TMDX's.
Critically, this is the big step in getting its aviation service off the ground and running [pardon the pun]. It will now have the infrastructure needed to generate sales and profits off its own capital, versus relying on 3rd parties to do so.
Moreover, it will ensure it misses no cases going forward. Management said it missed a few lung cases given the logistical challenges of using external aviation services, due to the capacity constraints. This will absolve all these issues in my view.
Critical points on these capital allocations going forward:
- The company wants to purchase additional aircraft to bring its operating fleet out to 10-15 aeroplanes by H1 FY'24.
- As to the look of this operationally-expect at least aircraft at 8 of its logistics hubs throughout the U.S., from 15 locations. Management said that with 8 crafts, it can cover 100% of the U.S. in geography.
- Hence, the plan to put 15 planes [potentially one at each hub, or a few at 8 of these], capacity is now at multiples higher than previously.
- It will build a central dispatch centre for its national operations in Massachusetts. That is, the central hub will dispatch air logistics from the 8 hubs mentioned earlier, at least to start off with.
- The CapEx requirements on this are estimated to be $96mm at the upper end of my assumptions, otherwise ~$12mm per plane for the 8 planes. Say it gets to 15 planes operating, it would be a CapEx of $180mm [management confirmed it will be purchasing vs. leasing for the time being]
The $180mm CapEx gets me to $202mm in assets (less cash) described earlier. Thinking in terms of combinations and permutations-i.e., what's likely to happen, and how likely is it to happen-my confidence is in TMDX getting the 15 planes on around about this capital charge. On my H2 FY'24 gross profit assumptions of $267mm, I get to 132% gross return on capital on this.
Therefore, the new additions add relatively thin overhead whilst adding immense value to the company's profitability in my view.
Figure 5.
(3). Technicals and valuation
A few points on the market generated data reveals plenty about the importance of maintaining a long-term view. The trend analysis I completed looks to the two cloud charts below [Figure 6 and Figure 7, respectively]. In Figure 6, the daily chart, you'll note the stock testing the cloud top, whilst the lagging line is still above the cloud. This is a critical juncture for TMDX, and demand will need to fill in with buyers at these levels in order to prevent a further correction in my view. This could be a risk in the near-term, because the daily chart looks to the coming weeks.
Figure 6.
Looking to the weekly chart, that looks to the coming months, we are still firmly positioned above the cloud even with the correction. There is good width before a test at the cloud top, thus telling me the long-term trend is still bullish. This is a clear testament to keeping a long-term view in mind, not getting clouded by the daily machinations of the market.
Figure 7.
As to valuing the company's equity stock, investors are selling TMDX at 13x forward sales, and valued the company's net assets at 15.7x. This tells me investors are paying $15 for every $1 in book value for the company, and that management is creating immense value for shareholders as a result. Last time I valued the company as a multiple of sales growth but given the recent capital allocations it's made I believe as a derivative of gross profitability is more appropriate.
My assumptions are detailed below. I've got TMDX currently trading at 24x trailing gross. Carrying this forward to H2 FY'24, I get to $150 per share in equity value. This is a value gap of 87%, representing the upside potential on offer. I therefore raise my price objective on TMDX to $150/share, supporting a buy rating.
Figure 8.
Data: Author
Conclusion
Based on the latest critical facts to the investment debate, I've reinstated TMDX as a buy, eyeing $150 as the revised price objective. To me, TMDX trades fairly on this estimate based on its current trajectory and the gross value add it is creating for shareholders. With a fleet of aircraft now in its arsenal, the economic woes caused by hiring external providers will be quashed, and the company can book returns on its own capital deployed in this regard. These, along with the points raised here today, corroborate a buy rating in my view.
For further details see:
TransMedics: Aircraft Additions Bring Immense Gross-Value Add, Reiterate Buy